June 27 (Bloomberg) -- Even in a business whose lifeblood
is borrowing, Magnum Hunter Resources Corp. stands out.

The Houston-based shale driller owes $891 million -- about
70 times more than its earnings before interest, taxes,
depreciation and amortization, or Ebitda, in the past year,
according to data compiled by Bloomberg. The industry average is
4.3.

The U.S. Securities and Exchange Commission opened an
inquiry last year into Magnum Hunter’s accounting that began
after the company’s auditor found “material weaknesses” and
Magnum Hunter dismissed the firm. Chairman and Chief Executive
Officer Gary Evans also rents his plane to the company, and he’s
chairman and interim CEO of another firm, GreenHunter Resources
Inc., hired to handle Magnum Hunter’s wastewater.

Investors have driven the shares up 127 percent in the past
year. Twenty of 21 analysts tracked by Bloomberg recommend
owning the stock. Out of five wells Magnum Hunter drilled in an
undeveloped corner of the Utica shale formation in Ohio and West
Virginia, three can’t produce because they don’t have pipeline
hookups and one was a gusher. The company and its investors are
betting on more of the gushers.

“We’re guessing,” said Gabriele Sorbara, an analyst at
Topeka Capital Markets Inc. in New York. “We don’t know until
they drill it.”

Lenders, investors and analysts backing a driller that’s
spending borrowed money faster than it comes in, with questions
about its future production and potential governance issues:
Welcome to the U.S. shale boom. Innovations in horizontal
drilling and fracking have pushed the country to the closest
it’s been to energy independence since 1987.

‘More Risk’

At the vanguard of the shale revolution are small producers
such as Magnum Hunter, with a $1.6 billion market
capitalization. North American drillers owe about $230 billion,
up 47 percent since 2010, even as revenue fell 17 percent to
$301.7 billion, according to an analysis of the 76 companies in
the Bloomberg Industries North American Independent Exploration
& Production Index.

“This is not a growth industry, but the only way companies
differentiate themselves is by growth, and growth comes with
more risk,” said Fadel Gheit, an oil and gas analyst at
Oppenheimer & Co. in New York. “Everybody is popping out
champagne bottles until everybody gets drunk and gets sick, but
so far the party goes on.”

Equity Stake

It’s not unusual that smaller drillers such as Magnum
Hunter spend more than they make and fund the difference with
bank debt, bonds, equity and asset sales, said Leo Mariani, an
analyst at RBC Capital Markets LLC in Austin, Texas.

“Theoretically it can continue forever,” Mariani said.
“It’s generally not seen as a major issue by investors.”

Some energy companies use Ebitdax instead of Ebitda to
measure profitability. Ebitdax also excludes exploration
expenses. By that metric, Magnum Hunter owes 6.8 times what it
earned in the past year. The company’s amended agreement with
lenders requires its debt to be no more than 4.75 times Ebitdax
in the three months ending June 30, 2014, according to a company
regulatory filing.

Magnum Hunter’s revenue has increased more than 17-fold
since fiscal year 2008 while its net loss has widened 32-fold.
The company has raised $200 million from selling land this year
and will increase cash flow from new wells, Evans said in an
interview. It also helped that in May the company raised $150
million in a private placement of equity from hedge fund
Relational Investors LLC, which received a 15 percent stake,
Evans said.

Best Play

Evans, 57, once turned $1,000 into $2.2 billion. After
starting his career in banking, he decided in 1985 at age 27 to
start his own drilling company. He had that initial four-digit
funding and hired his mother as the first employee, he said.

As the company, called Magnum Hunter Resources Inc., grew
in Texas and the Gulf of Mexico, “it got to where it wasn’t any
fun,” Evans said. He sold it to Denver-based Cimarex Energy Co.
for $2.2 billion in 2005.

As part of the deal, Evans couldn’t work in the industry
for two years. So he helped start an investment bank called
Global Hunter Securities LLC, and later cashed out. He also
pursued investments in wind power and biofuels through
GreenHunter.

Small Driller

Evans said renewable energy was too dependent on government
subsidies. He shifted GreenHunter to managing wastewater from
fracking, which involves blasting rocks deep underground with
water, sand and chemicals to unlock oil and gas. He also took
over a small driller and renamed it Magnum Hunter -- he’d kept
the rights to the name in the Cimarex sale. He leased land in
Texas’s Eagle Ford, North Dakota’s Bakken and the Utica shale.

The last patch excites him most, he said. In a slide show
for investors decorated with a photo of a stalking leopard,
Magnum Hunter calls the Utica potentially the best shale play in
the U.S. The company has leased 118,000 acres there, according
to a June regulatory filing.

“We’ll either drill it ourselves or we’ll be a prime
takeover target for somebody,” Evans said in the interview.

Test Well

Magnum Hunter said in February that one of its Utica wells
pumped 32.5 million cubic feet of natural gas a day. That’s one
of the biggest ever, according to Neal Dingmann, an analyst at
SunTrust Robinson Humphrey Inc. in Houston.

“If they can replicate that it would be a game changer,”
said Chad Mabry, an analyst at MLV & Co. in Houston.

The company is spending about $2.72 on capital projects for
every dollar of operating cash flow this year, Goldman Sachs
Group Inc. estimated. Losses per share will widen to 38 cents in
2016 from 25 cents this year, Joseph Stewart, a New York-based
Goldman Sachs analyst, said in a May 12 report.

Moody’s Investors Service changed Magnum Hunter’s credit
outlook to stable from negative and upgraded its rating on June
25, citing improved liquidity and “production visibility.”

To handle its wastewater, Magnum Hunter hired Grapevine,
Texas-based GreenHunter, of which Evans owns 47 percent.
GreenHunter charged $282,000 to rent storage tanks and $3
million for disposal services last year, according to regulatory
filings. GreenHunter’s total revenue was $25.7 million, meaning
Magnum Hunter accounted for 13 percent of its business in 2013.
Magnum Hunter also paid $22,000 to rent office space and
$122,000 to rent equipment from GreenHunter last quarter, the
filings show.

GreenHunter shares have risen 137 percent in the past year,
to $1.92.

Airplane Rental

Magnum Hunter also paid $166,000 in 2013 to rent an
airplane from Pilatus Hunter LLC, a company wholly owned by
Evans, according to Magnum Hunter’s annual report. In the first
quarter of 2014, the payment was $70,000, a 49 percent increase
from a year earlier, a regulatory filing shows. The rental price
is market rate and was approved by independent directors, Evans
said.

“Are you serious?” Evans said. “We’re talking about
$150,000 a year on a company generating $400 million in revenues
and you’re asking me about a private plane?”

Magnum Hunter reported revenue for 2013 of $280.4 million.
Its 2014 revenue will be about $444 million, according to the
average of 17 analyst estimates compiled by Bloomberg.

Fair Deals

Magnum Hunter isn’t the only company with a private plane
rented from an executive. Starbucks Corp., valued at $58.7
billion with stores in more than 60 countries, pays $269,297 a
month to rent a plane from its chairman and CEO, Howard Schultz.
Schultz repays the company for his personal use and hangar
space, according to a regulatory filing.

The deals for Evans’s plane and with the wastewater
management company he leads are fair, Evans said in the
interview. Magnum Hunter said the costs are competitive with or
better than prices available from unaffiliated suppliers,
according to a regulatory filing. The relationship isn’t a
conflict of interest because it’s reviewed by independent
directors at both companies, and it’s common for oil and gas
companies to buy services from affiliates, Evans said.

Accounting Work

Evans’s compensation from GreenHunter was $1.23 million
last year and $1.52 million in 2012, according to a regulatory
filing. Evans’s compensation from Magnum Hunter was $3.16
million last year and $3.99 million in 2012, a filing shows.

During 2009, 2010 and 2011, GreenHunter also did accounting
work for Magnum Hunter, according to Magnum Hunter’s amended
annual report for 2011.

Last year, PricewaterhouseCoopers LLP raised questions
about Magnum Hunter’s valuation of its oil and gas properties
and reserves, taxes and loan agreements. Magnum Hunter fired the
accountants, according to an April 2013 regulatory filing. In a
letter that month, PricewaterhouseCoopers said Magnum Hunter’s
financial reporting had “material weaknesses.”

The SEC opened an inquiry. Kevin Callahan, an agency
spokesman, declined to comment. Magnum Hunter reviewed internal
controls and plans to improve them, according to a regulatory
filing. A federal judge in New York dismissed a shareholder
lawsuit alleging the company misrepresented internal control and
accounting problems, Magnum Hunter said in a June 24 statement.
The company has won dismissals of five separate lawsuits and is
working to defeat the last one that remains, it said.

Shareholder Benefit

The SEC requires companies to disclose transactions with
company insiders so investors can assess the independence of the
board, and Magnum Hunter has done so.

Still, board independence appears to be a problem for
Magnum Hunter, said Nell Minow, founder and a director of GMI
Ratings, which evaluates governance risks at public companies.
Magnum Hunter’s payments show the board isn’t concerned about
the appearance or existence of conflicts of interest, she said.

“When we see these kinds of very insidery deals, it’s hard
to understand what the benefit is for shareholders,” Minow
said. “Most companies that were permitting deals like that have
cleaned up their act.”

Not all investors have stuck with Magnum Hunter. Randall
Yurchak, portfolio manager at Insight Capital Research &
Management Inc., said the possible conflicts of interest led him
to sell his shares earlier this year.

“Whenever you’re in a hot industry, investors are going to
give a pass to related-party conflicts and management issues,”
said Yurchak, who helps manage $470 million for the Walnut
Creek, California-based firm. “If the tide never goes out, you
won’t know what’s going on underneath.”